Gazing at the Futures

July 5, 2007byRob Bates

Like many in the industry, I am still absorbing and trying to understand all the diamond futures proposals — which I linked here – but a couple of thoughts have occurred to me:

Everyone agrees, for these schemes to truly work, they need industry support. Many trade bodies, such as the International Diamond Manufacturers Association, have been predictably cool to these proposals. (Two De Beers executives have spoken about it. They were skeptical but hardly hostile. Which is somewhat surprising.)

We all know this trade fears change, perhaps too much. But the record of investors meddling in this market is pretty dismal. At the Amsterdam President’s meeting, Rapaport and ABN-Amro’s Loet Kniphorst were both asked about how their proposals would prevent a recurrence of the 1970s investment boom-turned-bust. Both said something to the effect of “that’s a good question.” Yes, it is.

The after-effects of the 1970s investment boom weren’t merely bad. They were catastrophic. They nearly destroyed this industry, and put a lot of people out of business. That doesn’t mean events will unfold the same way again. But it does mean we have to be careful. Proponents of a futures market need to clearly explain why things will be different this time. Charles Wyndham has said these concerns are “painfully hormonal.” That is not much of a reassurance.

As a general rule, I think the diamond market works best when it deals with people who are committed to it for the long-term. Most investors don’t fit that bill.

On the same subject, one well-informed emailer sent the following:

The Polished Prices proposal, backed by the banks, sees hedging as the rationale for trade and industry participation. But how much do they participate in precious metals futures? Even among larger companies, there is not a lot of hedging, though it has increased with the raise in metals’ prices.

[It does] raise an issue, though: how do you deal with professional speculators or hedge funds shorting or attempting to corner such a thin market? The sums involved in financial markets are mega billions, not a few hundred million dollars. What would happen if speculators wanted to buy then sell, say, $2bn in diamond futures? Traders would fall over themselves to sell old inventory. But who would be ready to buy the goods back when the speculators came to sell? That’s probably why the thinking is gradually moving towards some sort of index contract without physical delivery …

I notice nobody has raised the option of offering a futures contract in rough. … Pricing is even less transparent there, though producers use price books and a number of independent valuators [such as WWW, which owns polishedprices] are in a good position to provide price information.